Betting on BP Stock Is Risky, but Potentially Rewarding

BP stock could be a winning bet for investors looking for value in the oil patch

Although BP (NYSE:BP) had a rough December, under current conditions BP stock is a value proposition for two distinct reasons. The first is that the energy sector could be ramping up, and as it does, European stocks look attractively valued compared with their U.S. peers.

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Investors looking for sectors trading at steep discounts relative to the broader market don’t have to look much further than the energy patch. In the U.S., where the energy sector has seen its weight in major equity benchmarks dwindle, the group, by some estimates trades at double-digit percentage discounts to the S&P 500.

Broadly speaking, BP lacks the heft and quality of rival Royal Dutch Shell (NYSE:RDS.A,NYSE:RDS.B), but in 2020, risk-tolerant investors may be able to realize some upside with BP stock. As it is, BP already has some supporters.

“Strong project delivery, falling gearing and a clear CEO succession plan suggest a positive risk/reward,” said JPMorgan Cazenove in a note out last month, in which the brokerage firm anointed BP as its pick among European oil majors for 2020.

BP isn’t just an integrated oil firm. The company has significant footprints in biofuels, plastics and, believe it or not, alternative energy. In fact, the British oil giant recently inked a deal to supply Amazon (NASDAQ:AMZN) European data centers with solar power. Still, markets will view BP stock through oil lens, meaning the company’s share price remains tethered to crude prices.

Some Protection

BP sports a compelling dividend yield of 6.31%. That’s more than 130 basis points above the yield on Exxon (NYSE:XOM). However, 6% certainly qualifies as “high yield” and there are negative dividend action risks that come with high-yield stocks, Plus, BP has cut its payout in the past, something Exxon and Chevron (NYSE:CVX) have been loath to do, even during oil bear markets.

As 2020 unfolds, there could be good news when it comes to BP’s dividend. At the very least, a cut appears unlikely. Last year, the company scrapped its scrip dividend program.

Scrip dividends aren’t often found in the U.S., but the long and short of that scheme is that they allow investors to receive new equity instead of cash dividends, thereby diluting other investors. Plus, rising shares outstanding counts are a drag on per-share earnings.

Think of scrip dividends as the opposite of a share buyback plan. To go along with the good news of the scrip dividend elimination, the company is expected to grow earnings by 11% this year and bolster cash flow, both potential positives for BP stock and two traits that make a dividend cut unlikely.

On a longer-ranging basis, BP has an under-appreciated element within its business: a venture capital unit, BP Ventures, that makes investments in smaller alternative energy companies with the goal of finding at least five “unicorns” by 2025.

BP Ventures could take some time to pay off for investors, but with much of the developed world boosting green energy use, BP is unlikely to be caught off guard by that shift.

Bottom Line on BP Stock

For 2020, the dividend appears safe, if not capable of growth and that’s a solid foundation for considering BP stock. The company can probably break even at $50 per barrel, well below today’s oil prices, but investors may want to hear more about rightsizing capital expenditures and cutting costs, something BP is already doing.

“BP has already realized cost reductions of $7 billion, or 20%, from 2014 levels, primarily in the upstream segment, where it reduced the workforce by a third,” said Morningstar in a recent note. “With the firm already one of the lower-cost producers of its peer group, cost reductions will improve margins further.”

And yes, the shares are inexpensive at just 0.47x this year’s sales and 1.35x book value.

As of this writing, Todd Shriber did not own any of the aforementioned securities.